Confidence remains the key

Wed, 2013-05-29 12:34

So I’ve been perusing the most recent global economic outlook put together by the Organization for Economic Cooperation and Development(OECD) – something this group does twice a year – and found myself struck by a key piece of analysis delivered by Pier Carlo Padoan, the OECD’s deputy secretary-general and chief economist: namely, that “confidence” is what’s going to make the difference between a stronger recovery or regression for the world’s economy.

“Confidence is essential for both companies and households to boost spending, especially on investment, which continues to remain below average in many advanced and some emerging countries,” he said during the group’s annual forum in Paris this week.

“It is the duty of policy to rebuild confidence through credible medium-term frameworks involving all policy pillars: monetary, fiscal, financial, structural, and, especially in the case of the euro area, institutional,” Padoan added. “The policy mix should be balanced and based on multiple pillars, as relying only on a limited set of instruments could lead to renewed instability.”

With that said, the OECD predicts that the world economywill grow 3.1% this year before accelerating to 4% in 2014.

While those estimates marked a slightly more pessimistic view compared to the group’s last outlook report in November – when it forecast global growth of 3.4% for 2013 and 4.2% for 2014 – the U.S. is now predicted to be a “driving force” in growth this year with its economyprojected to expand 1.9% for 2103 and then accelerating to 2.8% in 2014; which would be the nation’s best rate of growth since 2005, Padoan stressed.

“While still disappointing, the global economy is moving forward, and it is doing so at multiple speeds. These multiple speeds reflect different paths towards self-sustained growth, with each path carrying its own mix of risks,” he explained.

“In the U.S., large imbalances had built up prior to the crisis and eventually erupted, but the economy has undergone significant adjustment, which is beginning to bear fruit,” Padoan (at right) noted. “The combination of a repaired financial system and a revival in confidence is driving growth. Private sector demand is stabilizing as household deleveraging is far advanced, house prices are rebounding and wealth accumulation is supporting consumption. Employment is growing, adding to confidence.”

There’s that word again: confidence. As long as we’ve got that, it seems, the economies of the world can finally turn the long-awaited corner towards heftier long term growth.

Ah, but turning that corner won’t be easy – especially for the U.S., as a lot of deficit spending and “easy money” policies over the last four years haven’t been able to generate the desired level of growth.

Indeed, Padoan cautioned that fiscal policy should reduce the effects of excessive tightening coming from across-the-board sequestration, by refocusing or limiting the cuts in the current year, while ensuring a credible medium-term consolidation path.

“Monetary policy should remain accommodative but vigilant, as declining benefits of further quantitative easing are likely at some point to be outweighed by increasing costs in terms of misallocation and excessive risk-taking,” he explained.

And that’s not the only worry. For example, in Europe, still-rising unemployment is the most pressing challenge for policy makers.

“Protracted weakness could evolve into stagnation with negative implications for the global economy,” Padoan warned. “Such a perspective would resonate negatively with large persistent risks of adverse interactions between weakly capitalized banks, public debt financing requirements and exit risks.”

Indeed, OECD projects that the euro zonewill remain in recession for a second year, with the European Union’s contracting 0.6% in 2013 and then returning to growth next year with a rate of 1.1%.

The good news (such as it is) from where Padoan sits is that in many European countries adjustment, both fiscal and structural, has been going on for several years and thus government debt ratios should start to decline soon with positive implications for market risk assessments.

“Once debt ratios begin to decline, only modest additional fiscal tightening would be needed to bring them to safe levels over the medium term,” he said. “The improvement in competitiveness in some countries also reflects structural efforts. However, reform fatigue is mounting as visible results in growth and jobs still fail to materialize, in part because reforms can take time to bring results but also due to the weak macroeconomic environment.”

There’s also this potential pitfall: outside the major developed economies, Padoan pointed out, are a large and heterogeneous group of “innocent bystanders” of both advanced and emerging market economies, without large pre-crisis imbalances and with solid growth in the recovery, but where new imbalances, often resulting from spillovers from the policy stance in other regions, are emerging through inflationary pressures and high and rising asset prices.

“In such a diverse, multiple-path environment, internal and external imbalances are more likely to increase than the opposite,” he cautioned. “Current account imbalances are still large and could be rising in the future, while unorthodox monetary policies are likely to generate shock waves both during their implementation and once they begin to be withdrawn.”

Thus national policy frameworks will be less credible if they conflict with each other or disregard spillover effects, Padoan noted: “Adjusting the composition of national policy packages in a cooperative fashion to facilitate rebalancing and minimize adverse spillover effects is necessary … and it is also possible.”

I guess then that all we can do is hope enough confidence is generated by such policy efforts that businesses and consumers gain confidence that things will turn out all right. Let’s hope that’s what happens at any rate.